The Strait Is Closed. Stocks Don’t Care.

Stocks have been on a tear lately, which, of course, everyone seems to hate. Pick your poison: a slowing labor market, the Strait of Hormuz closure, a new Fed Chairman, midterm elections, $39T in national debt, etc. There’s plenty to be worried about. On paper, things should be worse off than they actually are.

So, of course, if stocks are up, then they must be overvalued.

There’s a lot to unpack here. To help with this, I keep going back to a famous Jesse Livermore quote that sums up today’s situation quite nicely: “Markets are never wrong, only opinions are.” Livermore is saying that market prices reflect reality, while personal and “expert” forecasts are skewed by emotion and ego. Or, the paraphrased version: if you disagree with the market, you’re probably wrong.

What the Market is Telling Us

In my opinion, Jesse Livermore’s quote, “Markets are never wrong, only opinions are,” is mostly right. Never is a very strong word. As Obi-Wan Kenobi said in Episode III, “Only a Sith deals in absolutes.”

For the vast majority of the time, the markets are right. But I also believe the markets can be wrong, though it doesn’t happen very often. These moments usually show up at the extremes: euphoria on one end, panic-driven selloffs on the other. And I don’t think we’ve reached euphoria quite yet.

Here’s why I think the market, 99% of the time, is right and difficult to beat: the market price embodies all available information, news, and sentiment. Constantly. And the combination of those three is often more accurate than any single investor or analyst’s take. As new information becomes available and sentiment changes, the market attempts to price it in. It does this every day, every hour, every minute. The market is literally a calculating machine that is always running. Every trade, every headline, and every earnings call gets weighed and repriced in real time.

Right now, the market is telling us that we have reason to be optimistic. Perhaps it’s telling us that the Strait of Hormuz closure is not as dire as some feared. And perhaps the AI revolution is real, and the rapid rise in AI-related stocks is warranted. More on that later in a separate post. But let’s talk about the U.S./Iran War.

Why the Market Hasn’t Panicked Over the Strait of Hormuz

For a deeper dive regarding my thoughts on the Strait of Hormuz, read here: The Iranian War & Inflation

And here: The Strait Won’t Open Itself

A few reasons why I think the market is not in full panic mode. First, the last time we had an oil crisis, the OPEC oil embargo of 1973, gasoline accounted for 4.8% of the average American’s budget. Today, it accounts for 2%. Put simply, gasoline accounts for a much smaller share of the average American’s wallet.

A side note for those of us who live in California, where the average price per gallon is $6.15 (AAA): we rely on Middle East crude more than any other state in the country. And there is every reason to believe gas prices will rise even higher before they fall. The last tanker carrying Middle East oil to California just docked, and the next one won’t arrive until months after the strait reopens. (WSJ) Two of the state’s largest refineries have closed in the past six months. Dozens more have shut down since the mid-1980s (with oil companies pointing to California’s higher taxes and tighter regulations as the reason). And because there are no major pipelines connecting California to the U.S. shale boom, the state can’t easily tap cheaper domestic crude. We’re stuck importing from overseas. Also, Asian suppliers are now slowing fuel exports to California to protect their own supplies. All of this points to higher gas prices.

Reason #2: Net Exporter

Second point on why the markets have yet to panic: the U.S. has transformed itself from a net importer to a net exporter of oil.

It’s not quite the protective economic barrier as one would hope (gas, jet fuel, shipping fuel, etc have all risen), but it does leave us less exposed than other countries, especially Japan and Europe.

The real risk for a prolonged Strait closure is not higher gasoline prices, it’s higher inflation. And we saw its effect yesterday with annualized inflation figures coming in at 3.8%. If the Strait remains closed through the summer, we run the risk of much, much higher energy prices.

JPMorgan explains this particular risk quite well. “Global oil inventories are projected to hit an operational stress level in June or July (there are practical limits to which pipeline and other storage mediums can be drawn down, and countries may also preserve minimum emergency reserves). If the Strait is not opened by September, global inventories could hit an operational stress floor of 6.7-6.8 billion barrels, after which demand destruction would occur at a faster pace, mostly in Asia and Europe.”

I believe that there is ample incentive for both the U.S. and Iran to make a deal. Why? Because neither country wants this conflict to continue. But both are stuck in a stalemate: The U.S. wants Iran to give up its Uranium enrichment and to open the Strait, while Iran does not want to do either. But something will give. Eventually. When and how is anyone’s guess. But the market is signaling that we will avert a crisis one way or another. The market is watching all of this and pricing it in. So far, it’s saying the worst-case isn’t the most likely.

Ryan A. Hughes

Ryan is the founder of Bull Oak, a financial advisor in San Diego. He’s been listed in InvestmentNews 40Under40 and his firm has been named one of the fastest-growing by Wealth Management Magazine.